The concept of crowdfunding has flourished in recent years. Often promoted across social media, it brings investors together to finance business or other ventures. For the most part, it originally financed causes that people believed in. Financial rewards weren’t always the main goal.
An early example of online crowdfunding took place in 1997 when Scottish rock band Marillion asked U.S. fans to help finance a tour to accompany the release of its seventh album. The band was no longer at the peak of its popularity, but its U.S. fans displayed their desire to see their heroes live by raising the $60,000 required.
Increasingly, crowdfunding is being used by businesses to raise money from investors who do expect some form of pay-out.
This takes two main forms: equity and debt crowdfunding. The former gives investors a share of a business or project. If successful, the value of this share goes up; if not it goes down – sometimes to zero. In a sense, this method of crowdfunding allows individuals to become very small-scale private equity investors.
Debt crowdfunding involves lending. In theory, lenders receive their money back with interest. This allows businesses to borrow money while bypassing banks.
With equity crowdfunding, valuations can generally look steep and regulation rather loose compared to those that governed listed-companies In the case of debt crowdfunding, if debt offered equity-type returns, it could carried equity-type risk.
But there are some investors who have demonstrated a thorough understanding of the risks. Some investors view their investment like a charitable donation. Such a perspective is that if the company was successful, it would benefit humanity and on top of that, the investor would receive some return.
There are also investors, in soccer clubs for example, who invested out of a sense of loyalty and a desire to be a part of the club that they loved. Financial reward was low on their list of priorities. In another example, investors add to small rock bands crowdfunding with fans getting their name mentioned on the album sleeve. Again, there was little expectation of financial reward, but what is the price of immortality and the ability to listen to an album from the band you love that might not otherwise have come to fruition?
BrewDog, a craft brewer founded in Fraserburgh, Scotland in 2007, has been a big user of crowdfunding. It issues various tranches of “equity for punks” as the company’s founders described the new shares. There was much talk that night of the stratospheric valuations that were implied by the prices of this equity – figures that bore little relation to the valuations of comparable quoted companies.
The implication was that gullible investors were merely buying the “story” without regard to the risks – or indeed the underlying profitability – of the company. Again, the debate focused on “other” reasons to invest, with some participants attempting to find brewing transactions globally that could justify the lofty valuation implied by the “punk” equity issues.
At the start of the month, justification for the valuation arrived in the form of a bid by private equity firm TSG Consumer Partners, for 22% of the company. TSG has invested £100 million (~$129 million) in new BrewDog equity, also buying £113 million ($146 million) of its existing equity. This gives the company an implied enterprise value (of the company’s equity and debt) of £1 billion.
It represents a significant (albeit, in many cases, implied) return for those early “punk” investors. To put this in some context, investors who bought one £230 share in the first crowdfunding round are now sitting on a shareholding worth £6590 – a return of 2765% since 2010.
However, the “punk investors” have also had a lesson in equity dilution, or the reduction in the existing shareholders’ ownership of their company. The issue document makes the deal subject to the “disapplication of pre-emption rights in relation to the allotment and issue of new shares” or the removal of their right as shareholders to vote against dilution of interests.
TSG also gets to buy new preference shares. In the event of a liquidation, return of capital or a sale of the business, these shares stand to receive a return of 18% per annum or the rate of return that ordinary shareholders get, whichever is higher. Certainly good equity if you can get it. Shareholder rights are important and valuable – one gives them away at your peril. How important they are in this case – and how valuable – will undoubtedly be tested in the years ahead.
So what are the lessons to be learned?
In BrewDog’s case, a company went from a garage start-up to a billion-pound enterprise, not unlike some other start-up stories that have been coming in technology. But there are few companies that will ever achieve this. While a measure of scepticism is always a good trait in an investor, in this case, it seems the crowdfunders may not have been as naïve as was initially suspected.
Companies mentioned for illustrative purposes only and should not be taken as a recommendation to buy or sell any security. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks may be enhanced in emerging markets countries.